A special report on China: Government’s role in industry

The long arm of the state

The government is flexing its muscles in business

Jun 23rd 2011 | from the print edition

ONE OF THE privileges that urban hukou holders enjoy is access to jobs in the state sector in the cities where they were born. In the late 1990s such work might have sounded precarious as China closed down or sold off thousands of state-owned enterprises (SOEs), throwing millions out of work. But those SOEs that remain are giants: 121 controlled directly by the central government and thousands of others run by lower-level authorities. Chinese students used to aspire to a job with a foreign company. Now they are more likely to want one with an SOE.

This may seem an odd choice, since the dynamism in China’s economy is mostly generated by non-state firms. From 1999 to 2009 the state’s share of industrial output by value fell from 49% to 27%, according to a recent report by Unirule Institute of Economics, an independent think-tank in Beijing. In 1999 government-controlled firms owned 67% of industrial capital; a decade later their share had fallen to 41%. But in the industries that pay the highest salaries, state firms dominate.

A new shorthand has entered common parlance: guojin mintui, meaning the state [sector] advances and the private retreats. It seems to suggest that the state sector’s share of the economy is growing, which it is not; non-state businesses are in fact prospering. But the government has been muscling in on business in a variety of ways. It has been tightening its grip on some industries it considers “strategic”, from oil and coal to telecommunications and transport equipment. It has been devising market-access rules that favour state firms. And to the chagrin of private businesses, it has allowed state companies to remain active in a surprising range of palpably non-strategic sectors, from textiles and papermaking to catering. In recent years property development has become a lucrative sideline for government businesses. “The tentacles of state-owned enterprises extend into every nook where profit can be made,” writes Zheng Yongnian of the National University of Singapore.

Of 42 mainland Chinese companies in the Fortune 500 list of the world’s biggest firms in 2010, all but three were owned by the government. Carl Walter, a Beijing-based investment banker, said in a recent book that getting as many companies as possible into that select group was a matter of deliberate policy. China’s own list of the 500 biggest Chinese companies spans 75 industries. In 29 of these not a single private firm makes the grade and in ten others they play only a minor part. The government-owned enterprises in these 39 state-dominated sectors control 85% of the total assets of all the 500 companies in the list, according to researchers from the China Enterprise Confederation which compiled it. In 2010, 75 of the confederation’s list of the 100 biggest publicly traded Chinese firms were controlled by the government.

Some Chinese economists worry that the government’s response to the global financial crisis will bolster state enterprises and their bad habits at a time when they urgently need reforming. As the confederation’s researchers put it, much stimulus spending has involved “swapping from the left hand to the right hand”: the state lending to the state. “We do not do privatisation,” declared the head of China’s parliament, Wu Bangguo, in March, ignoring the fact that China had done a lot of it only a few years earlier. In the banking sector, says Yao Yang of Peking University, the government has been increasing its dominance in the past couple of years. Many Chinese economists call for interest-rate reforms that would allow banks to offer higher returns on household deposits (real interest rates are often negative). But banks do not want to lose the profits they make from the wide spread between government-controlled deposit and lending rates.

Unirule noted that the profits of state-owned industrial companies had increased nearly fourfold between 2001 and 2009. But their average return on equity was less than 8.2%, whereas that of larger non-state industrial enterprises was 12.9%. Factor in the low cost of borrowing enjoyed by SOEs and their access to land at below-market prices, the report said, and their real return on equity between 2001 and 2009 was minus 1.47%. They are, in effect, destroying capital.

Not pulling their weight

There are far better uses for their excess profits. Homi Kharas and Geoffrey Gertz of the Brookings Institution, a think-tank in Washington, DC, argued in a book published last year that if state-enterprise profits were used to help the government reduce all workers’ social-insurance contributions, which currently make up about 35% of the remuneration of those in formal jobs, “China’s middle class, most of whom are salaried workers, would instantly grow.” The government has been requiring state firms to pay dividends since 2008, but many Chinese complain they are not offering enough and the money is being used to help state enterprises. The highest rate, paid by the most profitable ones, including the telecommunications, energy and tobacco industries, is 15% of post-tax profits—still very low compared with payouts by state firms in other countries. Even some official media have joined in the state-enterprise-bashing. A commentary on a government news website said they had “not played a positive role in improving social harmony”.

Some foreign businesspeople complain that market-opening measures initiated in the 1990s and early 2000s have run out of steam. Many saw China’s accession to the WTO ten years ago as a great impetus for reform. But when the country reached the end of its transition period in 2006, its will faltered. Many foreign companies still report doing good business. But especially since the global financial crisis, the government has been widely accused of twisting rules in favour of its state-owned or, sometimes, private-sector favourites. In a forthcoming book, “China’s Regulatory State: A New Strategy for Globalisation”, Roselyn Hsueh of Temple University says China’s strategy of “economy-wide market liberalisation and sector-specific reregulation” has enabled the country to “retain an upper hand over foreign forces even in a more liberal environment”.

Local governments sometimes play a decisive role in determining which firms succeed and which fail. Take Himin, a manufacturer of solar water heaters based in the city of Dezhou in the northern province of Shandong. Himin is a private company, but it is the local government’s champion. Together Himin and the government have devised a branding strategy for Dezhou as China’s “solar city”. The government has helped Himin to grow by requiring apartment buildings to be equipped with solar water heaters and by subsidising solar-heated bathhouses in villages. This leg-up has been crucial. The firm says it is now the world’s biggest manufacturer of solar heaters. In turn, Himin has been crucial to the success of Dezhou’s leaders, who last year hosted a big international conference on solar energy—in a 200m yuan solar-powered conference centre built by Himin.

Himin knows how to curry favour. In 1998, before it became fashionable, it set up a party branch whose work so impressed the leadership in Beijing that a member of the ruling Politburo paid it a visit. Himin’s rewards for good behaviour include a seat on the national legislature for Huang Ming, the company’s founder. One of the party cell’s benefits, says an official account, has been to establish a “channel for understanding the direction of [government] policy”.

Innovation by all means

Far more worrying to foreign businesses is a more overt form of government intervention involving support for Chinese companies that develop new technologies and discrimination against their foreign competitors. Complaints about this began to surface five or six years ago but have been growing much louder in the past two years. James McGregor of APCO Worldwide, a consultancy, described the government’s strategy in a report last year as a “massive and complicated plan” to turn China into a technology powerhouse by 2020 and a global leader by 2050. He said it was “steeped in suspicion of outsiders” and constituted “a blueprint for technology theft” on a large scale.

This scheme to encourage what the government calls “indigenous innovation” focuses on seven “strategic” industries, from alternative energy and low-carbon-emitting vehicles to information technology. First Financial Daily, a Chinese newspaper, reported that investments by these industries could amount to as much as $1.5 trillion over five years, of which the state is likely to contribute 5-15%. Mr McGregor says the scheme involves creating new Chinese technologies on the back of foreign ones supplied by companies eager for a share in the government’s massive spending. Some Chinese scientists have complained about the likely waste involved in state-directed R&D, but the party loves big projects too much to listen.

Foreign businesses in China have fought most bitterly over a new government procurement policy, launched in 2009, that favours products listed in catalogues of “indigenous innovation” technologies. They feared that the new regulations would shut them out of a multi-billion-dollar market. Under considerable international pressure from Western governments, Chinese leaders relented, promising that products supplied by foreign-invested firms in China would be treated like those of Chinese businesses. But in a recent report the American Chamber of Commerce in Beijing said several regulations still needed to be changed before these pledges could be implemented. In a survey a quarter of its members said they were already losing business because of “indigenous innovation” policies and 40% expected business to suffer in the future. Most of the American high-tech companies in China covered by the survey expressed concern.

China’s state-sector reforms in the 1990s went for the low-hanging fruit. A decade ago angry workers were easily cowed into submission by police or bought off with handouts. But any further reform would affect the interests of people in the top echelons of the party as well as their families, who have extensive connections with state-owned firms.

Zhu Rongji, the former prime minister whose reforms obliterated many of China’s state-owned firms in the late 1990s, has also gone on the attack. In April he made a rare public appearance at his alma mater, Tsinghua University. He handed over copies of a four-volume collection of his speeches, due to be published later this year, and pointedly invited readers to “make comparisons with the situation today”. To his supporters, the present looks grim.